Nordstrom Inc. Rewards Its Shareholders

In May, Nordstrom announced an agreement to sell its credit card receivables to Toronto-Dominion Bank , making TD Bank its exclusive U.S. card issuer. The move was designed to free up the substantial capital Nordstrom had invested in the credit card business to finance customers' purchases.

Nordstrom completed the sale of its credit card portfolio last week. Photo: The Motley Fool.

Last Thursday, Nordstrom revealed exactly how it will use the proceeds. As expected, the retailer will return the vast majority of the cash it is receiving to its shareholders.

Nordstrom details its plans

Nordstrom had already hinted in August that shareholders would get a big windfall from the credit card deal. During the company's Q2 earnings call, CFO Mike Koppel stated, "We expect to receive approximately $1.8 billion in net proceeds at closing. Because we are planning on fully funding our long-term growth through our current operations, we're not intending to apply the proceeds to our incremental investments."

Nordstrom's planned allocation of the sale proceeds fits that framework. On Thursday, the company reaffirmed that it will receive $1.8 billion after covering $35 million-$45 million in transaction costs and paying off $325 million of debt tied to the credit card receivables.

Roughly $900 million will be returned to shareholders through a $4.85 per share special dividend that will be paid on Oct. 27. That represents a yield of 6.5% relative to Nordstrom's Friday closing price of $75.12.

Nordstrom also added $1 billion to its share buyback program, with the authorization expiring on March 1, 2017. That comes on top of the $591 million remaining on Nordstrom's previous share buyback program, scheduled to expire on March 1, 2016.

In practice, the credit card proceeds will provide the cash flow for Nordstrom to finish the 2016 buyback within the next few months. With capital expenditures peaking this year, Nordstrom should generate enough free cash flow next year to complete the new $1 billion buyback expiring in 2017. In total, the $1.591 billion in outstanding buyback authorizations would allow Nordstrom to retire about 11% of its shares at today's stock price.

Don't fear the short-term EPS impact

Unlike a typical retailer credit card sale, where the bank would take over all aspects of the credit card business, Nordstrom arranged to retain the credit card servicing functions in-house despite selling the loan portfolio to TD Bank. This was designed to ensure that the customer experience stays at Nordstrom's standards.

The result is that Nordstrom will continue to incur some expenses for servicing the credit card portfolio, offsetting some of the revenue sharing it is entitled to from TD. In August, Nordstrom projected that it will initially retain about half of the earnings before interest and taxes (EBIT) that it has been generating from the credit card business. Last year, credit segment EBIT totaled $202 million.

According to Cowen retail analyst Oliver Chen, the loss of half this income would reduce Nordstrom's earnings per share by $0.30 annually. However, buying back $1 billion of stock would more or less offset the lower earnings by reducing Nordstrom's share count. That makes the $4.85 special dividend almost like "free" money for Nordstrom investors.

This demonstrates the importance of focusing on capital efficiency and not just earnings. Nordstrom's credit card business generated a steady stream of earnings, but it didn't earn a very good return on invested capital compared to Nordstrom's core retail business.

As a bank, TD should be able to fund Nordstrom's more than $2 billion in receivables at a much lower cost. (After all, bank accounts pay nearly zero interest these days!) The credit card transaction should thus be a win-win for Nordstrom and TD.

TD Bank will earn a good return on its investment in Nordstrom's credit card portfolio thanks to its low cost of capital. Meanwhile, Nordstrom will be able to distribute some of its capital to its shareholders, improving its return on invested capital.

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The article Nordstrom Inc. Rewards Its Shareholders originally appeared on

Adam Levine-Weinberg owns shares of Nordstrom. The Motley Fool recommends Nordstrom. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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